Marketing with options and forwards

1/1/2011

Applying financial options to consumer marketing pays.

After the final buzzer sounds at the NCAA men’s basketball Final Four, fans send payment to the league lottery for tickets to next year’s tournament. Months later, the lucky receive tickets. Everyone else gets reimbursed and must buy tickets on the private market, often at inflated prices.

Marketing professors Sridhar Balasubramanian and Barry Bayus and Preethika Sainam (PhD ’08) developed a mathematical model of the league’s ticket-pricing decision to devise alternatives to the lottery that will reduce scalping and increase the likelihood that fans who truly intend to go to the games receive tickets.

They adapt and apply the options and forwards concepts from the financial field to consumer markets. “Both options and forwards, as mechanisms, create more flexibility for the consumer,” Balasubramanian said. “The option mechanism is not in use in consumer markets, and our research is ahead of the curve, whereas the forward mechanism is already out there.”

They wrote about consumer options in the Journal of Marketing Research, and now they are working on a consumer forwards project. Their work is the first to build the concept of consumer options and analyze forwards’ empirical performance in consumer markets.

Options and forwards can mitigate risk. In the financial market, for example, an option could take the form of a contract between a buyer and a seller that gives the option holder the right to buy an asset at a specified future date at an agreed-upon (strike) price. The buyer pays a fee for the opportunity. The buyer is not required to buy the asset, but if the strike price is lower than market value on the agreed-upon date, the buyer would want to purchase the asset and lock in the profit. Options don’t control the price of the asset, but they can protect the holder from the risk of investing heavily in a risky asset.

A forward operates in a similar manner, but the buyer is required to purchase the asset on the agreed-upon transaction date, regardless of whether the agreed-upon price is lower than market value at that time.

The researchers used Final Four tickets to create a model for applying options and forwards in the marketing arena. The options model would appeal to UNC fans who want to go to the Final Four only if UNC makes it. They would pay a fee for the option to buy tickets once the playoff teams were known and have until a preset date to buy them. If they decided not to buy them, they would lose only the fee paid to hold the option and the league could sell them to someone else.

A forward in a sports market is always associated with a specific team. A fan holding a UNC forward would be required to buy the ticket only if UNC makes the Final Four. As soon as UNC secured a spot, the forward holder’s credit card would be charged. If UNC did not make the Final Four, the forward would expire. A forward fee is usually lower than an option fee because a fan holding a forward on a team would not have the luxury of deciding not to purchase the ticket if the team made it through.

“Forwards complicate pricing, of course,” Bayus said. “Now we have more tools, databases and processing power to handle more complicated pricing models.” According to their research, however, consumers seem to understand the consumer options and forwards concept.

Consumer forwards can benefit the market’s demand and supply sides. On the supply side, forwards could allow firms to conditionally sell the same seat multiple times to fans of different teams. Only the fan whose team makes it to the Final Four pays the exercise price and occupies the seat. Other forwards on the seat expire. On the demand side, fans can invest modestly to reserve a seat, subject to their team making it to the game, and are not left scrambling to buy a seat or sell a costly ticket that has little interest once their team is eliminated.

The researchers analyzed data from a firm that introduced consumer forwards in the Final Four market. The firm operated a marketplace where consumers could buy or resell forwards on specific teams. The researchers’ analysis of empirical data uncovered key influences that drive consumer behavior in the sports forward market. They also derived insights about how consumers can moderate their reactions to emerging information, including recent team performances, so that they buy or resell forwards at the optimal points in time, rather than under- or over-react to such information.

The general principle of forwards can be applied across multiple product and service markets. Hotels near the basketball arena over a Final Four weekend could use forward pricing to make sure that fans with tickets had places to stay. A ski resort could sell forwards conditional on the presence of at least six inches of snow on the slopes.

Forwards are simpler to apply than options, Bayus said, because capacity management becomes easier with forwards.

“Options are like overselling airline seats,” he said. “Sometimes it works out, but sometimes people get bumped. Forwards are much more tightly managed. You can sell the same seat multiple times over with confidence, because only two of the teams are going to make it. The others automatically lose the right to buy the seat.”

Options and forwards can limit scalping by reducing the amount of time that tickets are in play. Forwards offer other mechanisms to ensure that the ticket buyer is the same as the person sitting in the seat. For instance, in order to enter the stadium, the ticket holder would have to swipe the same credit card used to buy the seat.

“Risks can impede market efficiency,” Balasubramanian said. “Managing risks through options and forwards protects buyers and sellers, at the same time it brings more customers into the market and ensures that the fans who most want to see those specific teams play are the fans ultimately sitting in the seats.”

Key take-aways:

Options and forwards are not just financial instruments. They can and should be applied in many market contexts.

Pricing with options and forwards creates flexibility for buyers and sellers.

The use of consumer options and forwards can be a win-win; they are profitable for companies and desirable by consumers.

Sridhar Balasubramanian is the Roy and Alice H. Richards Bicentennial Distinguished Scholar and associate dean of the full-time MBA and MBA@UNC Programs.